Quick study: Luigi Zingales on crony capitalism

When business and government are bedfellows

LUIGI ZINGALES is a professor of entrepreneurship and finance at the University of Chicago’s Booth School of Business. He is director of the American Finance Association, and a research fellow for national economic research centres in America and Europe. He co-authored “Saving Capitalism from the Capitalists” (2003) and his latest book, published this year, is “A Capitalism for the People: Recapturing the Lost Genius of American Prosperity”.

Why do you say that America’s political system is degenerating into crony capitalism?

There is not a well-understood distinction between being pro-business and being pro-market. Businessmen like free markets until they get into a market; once they are in it they want to block entry to others. Pro-marketeers want free markets at all times. The more conservative pro-marketeers are fearful of criticising business, because they assume they will be seen as criticising the free market. But we need to stand up and criticise business when business is not helping the cause of free markets.

In what way?

Take lobbying. Lobbying may once have been reactive but now it’s proactive—businessmen use it to shape policy and ask for tax advantages. This is corruptive of democracy.

Examples, please.

Companies with a lot of money abroad sponsored a bill in 2004/5 that allowed them to repatriate their profits at a low tax rate. Thus $1 produced $220 of tax savings. The Bush-approved drug and Medicare act was a huge bonanza for the drug industry. Their market value increased by several billion dollars when this was announced. I could continue.

I get the picture.

The last element that worries me is the disaffection of people. They don’t get enough from the game. The ordinary American is making less than his father. Until 1975 the take-home wage of a typical worker was going up in sync with productivity. Since 1975 that wage has stayed flat. Why? Because of the health-care costs. The cost of health care is rising in America and it’s eating up the benefits of increasing productivity for workers.

So, what do we do now?

There should be more competition in areas that are subsidised by, and distorted by, the government. Health care is one of those areas. Tertiary education is another. I work in a sector that is heavily subsidised and in which prices have gone up every year in real terms, to the point where the average American cannot afford to send their kid to college. We see people giving up and not participating in the labour force because they are uneducated—their chance in life is jeopardised in a major way. We need to improve the quality of education. One way, documented by a Stanford professor of education, is to fire the bottom 10% of teachers. This makes the average quality of teaching substantially higher.

Then you wouldn’t have enough teachers.

You could hire more. In reality we don’t look enough at performance in the educational sector.

Isn’t rating teachers on their performance and having competition in schools to attract more business quite brutal?

I believe that more competition in education is good. The major criticism of the voucher system [which lets parents use government funds to pay for private education] is that it doesn’t give enough chances to disadvantaged kids. This problem can be fixed by a form of voucher that is contingent upon your starting point [ie, related to your basic income]. As long as there is competition and there is no subsidy then I’m fine with it. If more people believe in non-commercial options then the co-operative will do better.

Okay, so we’ve got competition in health care and education. What else?

We have to change the way economic policy is run. An unregulated market is a jungle, not a level playing field. However, there is a risk that regulation will be designed to protect incumbents. We need control by the people—when a piece of legislation is simple enough to be debated by the public at large it is less likely to be captured by a vested interest. But when you start having regulation that is 2,400 pages long you know it’s designed to help insiders.

Regulation should also be accountable. A colleague of mine tried to study the performance of the banks’ regulator. When he started coming up with conclusions that the Fed didn’t like, his access to the Fed’s data was discontinued.

That’s surprising. One thinks of America as being incredibly transparent.

The image is better than the reality. Take Fannie and Freddie; they could get away with not providing any data because they were government-sponsored, not government agencies, and so not subject to the freedom of information act.

The policy today is intervention with government subsidies in order to promote this or that sector. Why don’t we abolish all intervention in the form of subsidy and use selective taxation instead? I propose a tax on lobbying. It would be a very effective method in terms of economic policy.

If you tax lobbyists then won’t you get the richest people, those who can pay the tax, having the most influence as usual?

No. If you tax lobbying in a progressive way then it reduces the influence of the largest companies on the important decisions. People lobby because there’s a high return, but if you start taxing them and using some of that money to subsidise the opponents then it evens out.

It is. As economists and business-school professors we have to take more of a stand on the right and wrong way to do business. We are afraid to use the words moral or social norms, but by trying to be scientists we actually indirectly promote detrimental behaviours. What we do is look at the monetary costs and benefits, but there are many subjective non-monetary costs and benefits. If I only cared about money I wouldn’t be in academia.

Suggested reading: “Ethics and Economics, or How Much Egoism Does Modern Capitalism Need?: Machiavelli's, Mandeville's, and Malthus's New Insight and Its Challenge” by Vittorio Hösle (2011).

"There is not a well-understood distinction between being pro-business and being pro-market. Businessmen like free markets until they get into a market; once they are in it they want to block entry to others."

Adam Smith knew it back at the beginning. Businessmen hate competition. Free markets do not maintain themselves naturally, without government intervention to prevent their subversion.

"We have to change the way economic policy is run. An unregulated market is a jungle, not a level playing field. However, there is a risk that regulation will be designed to protect incumbents. We need control by the people—when a piece of legislation is simple enough to be debated by the public at large it is less likely to be captured by a vested interest. But when you start having regulation that is 2,400 pages long you know it’s designed to help insiders.

Regulation should also be accountable. A colleague of mine tried to study the performance of the banks’ regulator. When he started coming up with conclusions that the Fed didn’t like, his access to the Fed’s data was discontinued."

How we run economic policy is a symptom. So is regulatory capture. We need to eliminate our politics of open bribery. The distortion of taxes and regulations is a politician's stock in trade, what he sells in return for campaign contributions, sweetheart deals, and a revolving-door job. This cannot change until the voters grow so angry that pols fear them more than they fear and adore those who offer those irresistible delights.

That this truth is not at the core of political reporting demonstrates that the news media corporations are dodging the job in return for which they earn their special Constitutional protections.

This liberal misses the problem by a mile. The prescription drug benefit pales by comparison to what has occured in the US under Obama. The salient example would be Obama's regulatory onslaught. Obamacare, Dodd-Frank, and other administration initiatives dramatically increase rent seeking behavior by lobbyists, and stifle market competition by creating an oligopoly in each regulated industry. The government finds it easier to regulate a few large corporations, rather than many smaller ones, so it encourages combination and drives out competition. The corporations, such as the big banks, health insurers and drug makers, go along in an effort to increase market share by wiping out their competition.

At times we make a small error and we pay a lot for this. I remember when Al Gore was in Scotland and talked of the Global warming. We did not listen and now he is Former U.S. Vice President Al Gore is co-founder and Chairman of Generation Investment Management, a firm that is focused on a new approach to Sustainable Investing.Gore is also cofounder and Chairman of Current TV, an independently owned cable and satellite television network for young people based on viewer-created content and citizen journalism. A member of the Board of Directors of Apple Computer, Inc. and a Senior Advisor to Google, Inc. Gore is also Visiting Professor at Middle Tennessee State University in Murfreesboro, Tennessee.Mr. Gore is the author of An Inconvenient Truth, a best-selling book on the threat of and solutions to global warming, and the subject of the movie of the same title, which has already become one of the top documentary films in history. In 2007, An Inconvenient Truth was awarded two Academy Awards, including for Best Documentary Feature.Since his earliest days in the U.S. Congress 30 years ago, Al Gore has been the leading advocate for confronting the threat of global warming. His pioneering efforts were outlined in his best-selling book Earth in the Balance: Ecology and the Human Spirit (1992). He led the Clinton-Gore Administration's efforts to protect the environment in a way that also strengthens the economy. This is the way we lose good leaders NOT LISTENING May be we have the reason but I see non that could have stopped the snow melting as BBC shows in the TV I thank you Firozali A.Mulla DBA

US auto giant General Motors will invest a billion dollars in its Russian plants by 2018 to build more cars for the expanding market, a GM executive said Wednesday. "We will invest an additional $1 billion into Russia, expand the capacity of the plant in Saint Petersburg to 230,000 cars per year and of the joint enterprise with AvtoVAZ in Togliatti to 120,000," said Jim Bovenzi, the president of GM Russia, as quoted by Interfax news agency in Russian. The company also operates a factory in Russia's western exclave of Kaliningrad. Its total Russia investment has currently reached $500 million, Bovenzi said. Russia's car market has expanded over the last decade to become one of the biggest in the world and second only to Germany in Europe. In 2011 sales grew by an annualised 39 per cent to reach 2.65 million cars, according to a report by the accounting and advisory group Ernst and Young. US auto giant General Motors will invest a billion dollars in its Russian plants by 2018 to build more cars for the expanding market, a GM executive said Wednesday. "We will invest an additional $1 billion into Russia, expand the capacity of the plant in Saint Petersburg to 230,000 cars per year and of the joint enterprise withAvtoVAZ in Togliatti to 120,000," said Jim Bovenzi, the president of GM Russia, as quoted by Interfax news agency in Russian. US auto giant General Motors will invest a billion dollars I thank you Firozali A.Mulla DBA

Good, interesting article. Two quick things however, I didn't like the tax on lobbying piece. Its sort of knee-jerk when we see something we don't like in government, we try and use the government to free us from it. But govt is a blunt instrument; using a govt. tax to free us from lobbying the govt. is just muddying the waters and will be ineffective. The problem of lobbyists will go away when we fix our govt.'s meddling in the economy. Second, the author says "unregulated markets are like a jungle". He's falling into his own trap, assuming that the natural state is crony capitalism when we see that it is precisely regulation that leads to crony capitalism. We must de-regulate to escape from this.

This is a perfect example of how progressives and Marxists have operated for the past century now... give them control because of their utopian promises they destroy everything they touch and then in the wake of their destruction, which frequently includes millions of corpses, they start making up terms and phrases to try and hide their own culpability and deflect criticism from themselves for the own deeds.
There is NO SUCH THING as crony capitalism, it doesn't exist, it's a oxymoron fabricated by the kook left in an attempt to redefine their own failed policies in terms that their uniformed and ignorant followers will interpret as they wish. The use of the term IS Orwell's Double Speak in action.
When the government intervenes in the markets and begins picking winners and losers, favoring cronies, by definition capitalism ceases to exist. The actions and results describe ARE socialism and socialist are simply trying to re-brand it once again to obscure their failures.
The honest and accurate title of this piece should be "When business and government are bedfellows, it's socialism not capitalism and it always fails."

A tax on lobbying would be per se unconstitutional. There's this little thing called the First Amendment which includes the right to "petition the government for a redress of grievances." So, leaving aside whether taxing lobbying would accomplish its goal, it is entirely impractical, as you would never get the votes to amend the Constitution. Next idea?

The worst aspect of that is that most in government haven't the foggiest idea of what it is like to run a business and actually succeed with the real threat of actual failure. They do not understand the real effect of regulations on ability to efficiently produce. Not polluting is easy. The regulatory climate is a nightmare.

The only argument I disagree with is the tax on profits coming back to the US. The profits have already been taxed overseas, if the companies had to pay the full tax burden again, the money would never return to the US.

Good thoughtful article.However ,Cronyism cannot be eliminated whether its capitalism or socialism or whatever.Its just human nature like greed .

The article is well thought out.But who would implement it ? I would also like to add three more points.

1. In the teaching of economics the academicia should give importance to the concepts of SOCIAL JUSTICE and SOCIAL RESPONSIBILITY in making profits and its impact on economy in the long haul. .When markets are made the rulers then it would be profiteering that would dominate everything else.

2. In the internet age the speed of making profit has increased considerably Therefore the Gov ought to take radical measures to CONTROL THE SPEED OF INTERNET TRADING like the road-speeds are controlled.High-speed Internet trading should be taxed heavily and internet traffic-wardens should monitor and speed-violations be fined at punitive rates..

3. EDUCATION MUST INSTILL SOCIAL SENSE and CHARACTER BUILDING at all levels, from primary to tertiary .In an ivy-league educational institution, I had a student who had the following answer to the question,"what are the effective measures to reduce poverty ?" Her answer, "kill as many poor people as you can find" ,was an eye-opener more on our education system than on her state of immaturity.

Thanks to a kind commenter who responded to my Q about regulatory capture, I now understand what it is and how it works. It boggles my mind that with all the fancy manoeuvring, legalistic and otherwise, nothing is done ( or perhaps can be done? ) about the inherent flaw of conflict of interest in a system of regulatory bodies with built-in participation of the regulated. I mean greed is a universal corrupter to which few are immune. What can be done?

A whole bunch of valid points but now, how do we get to have that level playing field? How do we get to have open competition everywhere. Health care and education are two great examples of where it is needed and just doesn't seem to be happening. The problem is that groups are influential groups. They control money and votes and what politician is going to offend their donors? Helllppppp.

"People lobby because there’s a high return, but if you start taxing them and using some of that money to subsidise the opponents then it evens out."

But I thought you wanted to get rid of subsidies? The real issue in lobbying is that SUPPOSED opponents actually team up to lobby on behalf of the industry to protect themselves from truly disruptive competition or effective regulation.

A tax on lobbying is a bad idea and an unconstitutional restriction on free speech as well. If as the example provided shows, one dollar in lobbying gets $20 in benefits, the effect of a tax is simply a small nuisance cost. Besides, when more investment capital is at stake, it should have a proportionately larger voice at the table than those with little skin in the game.

"Tax on Lobbying"
Here is where psychological indoctrination occurs without people even noticing. Im sure that most people immediately think rich people, rich corporations lobbies influencing government; while completely forgetting that "lobbying" involves all kind of advocate groups: from Pharmaco and Oil industry lobbies, to prochoice / prolife groups, from NAACP to AARP to ADL, to gays, from enviromentalists to coal industries, pro/anti amnesty groups, etc. There is a lobby group in Washington for everysingle cause.